There is an over-riding problem with the euro: it is one of the few fiat currencies with some of the attributes of sound money. It is not perfect: the ECB has a problem keeping Euroland’s banking system solvent, which requires huge injections of newly-minted euros, but at least it is not printing money for government spending. This means that the weaker economies, such as Greece, are struggling to find solutions to their difficulties without the deceit of the printing press.
The unsolicited advice of economists is always based on the presumption of weak money. Advice to leave the euro and return to the drachma is typical and is not thought out – if Greece was to leave the euro it would be a huge set-back for European unity, and a new drachma presumably would become valueless in short order. It certainly would not be a currency the Greeks could use in the capital markets. The difference for ordinary Greeks is that with a new drachma only the black market spivs will survive, whereas with the euro, the government is bust while some of the private sector will remain intact.
The extent to which the private sector can actually survive and recover is compromised by the loan conditions. The IMF will presumably have Greece’s interests in mind, but when it comes to economic reconstruction is unlikely to have much room for manoeuvre, because the European Stability Fund’s principal concern is not Greece, but the French and German banks. This means that their interests are served by spinning the problem out as long as possible. The loan conditions will therefore keep the Greek economy in a zombie-like state, staggering on with all its blood sucked out of it but never actually dying.
This strategy only makes any sense if there is a Europe-wide economic recovery, which would allow the European banks to eventually rebuild their balance sheets. Predictably, this hoped-for recovery is stalling, which is bound to bring new strains into the banks on top of their current difficulties. Consequently, the option of playing for time is becoming null and void, and it is only a matter of when rather than if before markets seriously challenge the whole eurozone concept. The politicians seem blissfully unaware of this possibility. By way of confirmation, while Greek bond yields edged back a little on the parliamentary vote, there was no sign of Portuguese, Irish or Spanish rates easing. This indicates a deeper malaise not properly addressed by the European Central Bank’s current economic strategy.
All this raises the question as to whether or not the ECB will be forced into a far larger bank bailout, abandoning what little remains of its hard-money line. Institutional investors have recently pulled $39 billion out of US prime money market funds, switching $27bn into government bonds. We can take this as evidence of growing nervousness in capital markets about sovereign debt and the stability of the banking system.
The ECB will need all its expertise and a fair amount of luck if the eurozone is to remain intact.